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The Bruce Column — Agreeing the framework: Paul Druckman

Sep 06, 2012

The journey toward an agreed framework for a system of integrated reporting around the world is gathering pace. Robert Bruce, our regular, resident columnist, interviews Paul Druckman, CEO of the International Integrated Reporting Council (IIRC), about progress, the growing support of investors and analysts, the attitudes of stock exchanges around the world, and what it means to provide "more than the financials."

The definition of integrated reporting is disarmingly reasonable and logical. This is how it is defined by the IIRC: ‘Integrated Reporting is a new approach to corporate reporting that demonstrates the linkages between an organization’s strategy, governance and financial performance and the social, environmental and economic context within which it operates. By reinforcing these connections, Integrated Reporting can help business to take more sustainable decisions and enable investors and other stakeholders to understand how an organization is really performing’.

But if you look at the summary of responses, published in June[1], relating to last year’s discussion paper on integrated reporting you find that the simple concept has spawned many different ideas. ‘It was apparent from the responses that there is a diversity of views, and even a degree of confusion, about the definition of Integrated Reporting; about what Integrated Reporting is, or is intended to become; and how Integrated Reporting should relate to existing reporting strands (e.g. financial, management commentary, governance and remuneration, and sustainability reporting)’, it says. And it then goes on to say that: ‘Some respondents also questioned whether the work of the IIRC should relate to the broader concept of how integrated thinking is embedded in an organization and how this affects all facets of reporting, rather than focusing only on the features of a single integrated report’.

These are busy times for the IIRC. The process of moving towards an agreed integrated framework continues. Pilot programmes are underway to test ideas. A full consultation document is due next year. Efforts to create a regulatory framework are being worked upon. It is a remarkable experiment. Nothing is hard or fast. But the feeling that this is an idea whose time has come is strong. Research[2]published last month showed strong support from investors and analysts for the value of providing information on an integrated reporting basis. ‘Over 80% of our research sample believe that extra-financial information is very relevant or relevant to their investment decision-making or analysis’, was one of its findings.

Paul Druckman is CEO of the IIRC. He has a careful path to tread. He knows the momentum for change is there. But he also recognises the complexity of providing a framework which would garner wide acceptance. ‘I would describe the phase that we are in at the moment as creation and awareness raising’, he says. ‘So we are very busy creating the technical framework itself and we are very busy trying to explain globally what integrated reporting is, and it is not necessarily what people think it is. It is a tough ask’. But that is offset by the enthusiasm being shown around the world. ‘What is remarkable is the momentum continues to grow rather than calm down a little’, he says. And he refers to a meeting he had earlier on the day we spoke. ‘This morning I was talking to people from some of the Asian Stock Markets’, he says. ‘They are desperate to get on with it. If we had a framework they would already be busy implementing it, so it’s great’.

But he knows that such is the wide range of views around that it needs to be approached slowly and steadily. A draft prototype of the integrated reporting framework will be made available in September. It will then be modified and presented to the IIRC in Tokyo in November and in April next year the Consultation Draft will be published. And in the meantime the pilot programmes are up and running in 75 companies spread around the world. A conference in Amsterdam in September will discuss preliminary findings. Many of the companies involved are well on the way down the path to integrated reporting. Others are still assessing where the information required would best come from. ‘There are many companies that are well on the way and we are just a way of helping them move their ideas forward’, he says. On the other hand ‘very few of the companies have actually got on with the reporting and most of them have been investigating the silos in the business and where the data comes from and just how is this all going to happen’.

The task now is bringing all this together into a comprehensive consultation draft next year. The work so far shows that many companies are moving towards integrated reporting but they are all doing it in many different ways. Looking back over the first year of the work Druckman makes the point that while there are big differences there is also common ground. ‘I think what it’s done is confirm that we have to be more flexible’, he says. ‘So, let’s get away from the jargon of principles and rules and let’s talk about flexibility. I think we’re going to have to be possibly even more flexible than we expected. Different companies actually come at strategy from different points in the organisation. You’d think it would be common but it isn’t necessarily. And the drivers in different companies are different. We have to make sure that the framework doesn’t put people in a straightjacket which means that they can’t express themselves’. It is a lesson learned. ‘I think that we talked about flexibility right at the beginning’, he says, ‘but I don’t think we really understood why and I think we truly understand why now’.

Another lesson learned is that while the research shows that investors and analysts are enthusiastic about the value of the information provided by integrated reporting there are marked cultural differences and these do represent a big divide. It is what you might describe loosely as the emerging economies which are enthusiastic. The old world of long-established stock markets and investment patterns are less so. ‘It does depend on where you are’, says Druckman. ‘If you are sitting in New York or Toronto it is quite markedly different from sitting in Sao Paulo or Seoul’.

It is also a question of attitudinal differences. ‘We are now more aware than ever that our target audience for integrated reporting is the long term investor’, he says. ‘I would categorise it, actually, as the long term global investor. If you are a short term trader, somebody playing the market, well fine, you do what you do but we can’t help you. That’s not our role’. But he feels there is an overall understanding which is clearly apparent right around the world that financial statements alone tell far from the full story, or provide anything like the full information that management or investor requires.

‘I use the words ‘more than financials’ rather than ‘non-financial’ or ‘extra-financial’’, says. ‘Everybody has their own term. When I say ‘more than financials’ I think there is an understanding that the value of the business intrinsically is more than just what is in the financial statements, and I don’t think anybody denies that. How you capture that is the challenge, which I think is both cultural and regional’.

And one part of this is in the field of long-established regulation. The way integrated reporting works contrasts with much of the highly regulated detailed content-oriented securities legislation that exists now, especially in the US. The IIRC wants to get companies to focus on what’s important but in a future orientated manner. Druckman’s view is that the two approaches have to co-exist and gradually they will evolve. ‘We are not there to replace the existing compliance legislation’, he says. ‘Whether that existing compliance legislation and regulation actually evolve over time is not my place to discuss. I think the likes of FASB and IASB with the concept of management commentary and other measures are looking at that anyway, that’s their part of the world. I would say that integrated reporting is part of this reporting evolution and I could almost imagine a management commentary or an MD&A taking over from integrating reporting one day, but it’s not going to do it in the timescales that we will want’.

Companies are already changing, ahead of the regulators and standard-setters. ‘The detailed factual regulatory information and data that is already there is just not going to go away’, he says, ‘but companies are going to have to be more transparent, not just for investors but for society and their staff’. So the answer is to approach the issue from two angles. Firstly, integrated reporting does not replace existing standards or regulation. ‘The second angle is that we are there to help to provide a fresh look at how a business creates and preserves value’.

And this pushes at another boundary in existing regulatory framework – the vexed question of forward-looking disclosure. Lawyers tend to draw a deep breath. Company directors see it as a hostage to fortune. Auditors are uneasy, to say the least. ‘It’s why you can’t implement integrated reporting today to some extent’, he says. ‘I believe that one of the big barriers for integrated reporting is that the companies haven’t got that flexibility that they need. They may well be doing integrated reporting but they are not doing it in the way that they want to, many of them, because of legal issues and forward disclosure issues’.

For Druckman the answer is a change in regulatory culture. ‘You create a regulatory environment that understands that this is based on planning and guesswork’, he says and then hesitates. ‘Perhaps guesswork is the wrong word but I’ve been in business long enough to know that quite a lot of it is guesswork, guesswork based on lots of planning and other information, but it’s still not something you can guarantee. And a sophisticated investor needs to understand that that’s where that information comes from. I actually don’t think it’s very difficult, I just think it needs to be addressed’.

In part Druckman thinks that the solution to this lies in the different cultures around the world. ‘How we overcome the challenge is tough but it doesn’t mean that we shouldn’t create the opportunity’, he says. ‘What we have got to recognise is that there isn’t one route’. He gives an example: ‘What is so noticeable is the difference between the North Americans and the South Americans. There is a completely different mindset. The South American Exchanges are talking about how they can make a difference, how they can make change happen in their nations and with their companies and with their investors’. This, Druckman feels, was in sharp contrast with the North Americans. ‘Their attitude was “We maintain a stance of independence to the issues – we deal with transactions”. I’m not knocking them. There is a big competitive environment there and they are in a situation where there are big competitive tensions. If one exchange creates something that companies don’t want, another will pick up the business and the only way that they can see a way forward is if it’s done on a global basis, through the World Federation of Exchanges’.

‘At the moment we look down straight lines’, he says. ‘It may be that pressures come from the outside so that stock exchanges or regulators or governments say “hang on a minute, this landscaping is changing, we need to evolve”. If we just carry on down the straight line we’ll never get there, we have to find the pressures from outside’.

Druckman expects the process to develop faster than it might have done in the past. It took somewhere around twenty years for what have now become IFRS to reach a level of maturity to the point where they are taken seriously by the market and the market regulators. ‘It has got to come through a lot quicker than that’, he says, ‘but although we want it to be done quickly we realise that it is not going to be quite as quick as we hoped’. The framework will be developed by the end of 2013. But he expects that this, and he draws on his career in software here, will be version 1.0. ‘It doesn’t mean that it will be the complete answer’, he says. ‘I would be devastated if it wasn’t a very good answer but it won’t be the whole picture’. But he thinks that progress will be rapid. ‘I just think that things are more dynamic and I think people are ready. There is nothing so strong as an idea whose time has come’.

Meanwhile, a Sustainability Accounting Standards Board has been set up in the US. Intended to partner, though independent of, the existing Financial Accounting Standards Board, (FASB), the SASB aims to standardise the way that non-financial risk and broad sustainability data for US companies is reported. The aim is to ensure that the information, which currently doesn’t make it into the reported data, will be filed in each company’s primary disclosure form, the 10K, which has to be filed with the main US regulator, the SEC. This will provide the basis for wider disclosure than currently happens in the US market. ‘What the SASB is doing is trying to get data into the 10K’, says Druckman. ‘There’s nothing around the strategy of the business, the value of the business, all of that sort of stuff. It’s just saying let’s get some environmental and social data into a 10K. So, it’s adding to the information set and there’s nothing wrong with that and, in fact, if they create data standards and information standards - that actually supports the work of the IIRC’.

But the danger is that it will also add to the potential confusion between the different guardians of the corporate information. ‘The danger’, he says, ‘is that we’ll have a Global Reporting Initiative and an IFRS and a SASB and US GAAP and never the twain shall meet. GRI and SASB are not the same. For example, GRI is very stakeholder focused, SASB is very investor focused and compliance focused’.

Reporting on a global stage will require common information and methods of defining and recording it. ‘The fact that we don’t have really strong sustainable environmental and social indicators that are globally accepted is a weakness for integrated reporting’, says Druckman, ‘but it all supports integrated reporting, because we are not trying to recreate the 10K or add data to it. We’re saying that the 10K is fine, you can have your 10K. The real questions are: What’s this business trying to do and how’s it going to create value? It’s a totally different question. The 10K data is used to measure the past performance and indicate future performance in integrated reports, but it underpins it, it isn’t what an integrated report is, so in many ways the stronger sustainability reporting and financial reporting is, the stronger integrated reporting is’.

So where will integrated reporting be in five years time? ‘We will be implementing integrated reporting globally’, he says. ‘And financial reporting will be starting to evolve because it will no longer be seen as the core-only report of the business.’

And how will it evolve? ‘By its own nature it will change’, he says. ‘Nobody will force it. The prime annual report of corporations will be an integrated report and the financial statements will back that up rather than being the principal report. I would say that in five years’ time that starts and that process really starts to have real energy. I would see most listed companies around the world having an integrated report as their primary report’, he says. ‘That may be ambitious, but that is the aim’.

1 ‘Towards Integrated Reporting – Communicating Value in the 21st Century’. Summary of responses to the September 2011 Discussion Paper and Next Steps.

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